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It Was a Housing Bubble, Stupid

NEW YORK (
TheStreet) -- It appears that hundreds of people involved in securitizing mortgage loans heading into the real estate crisis, had no idea that the United States was in the midst of a housing bubble.

In the aftermath of the housing market collapse in 2008, there has been substantial research and press dedicated to analyzing the root causes of the crisis.

While some have blamed external factors such as a prolonged period of low interest rates and affordable housing policies, the popular view, especially among policymakers in Washington, has been that poorly designed incentives -- bonuses come to mind -- led Wall Street to take excessive risk in the mortgage market, leading to the collapse of the housing bubble and the demise of financial institutions including
Bear Stearns and
Lehman Brothers.

Recent research has increasingly suggested that securitization -- the process of packaging loans into securities that could be sold to investors -- may have been a major contributor to the bubble. Banks were arguably reckless in their lending, because they did not retain mortgages in their books and could pass on the risk to investors.

Investors also unwittingly believed that they were protected from the downside because they thought they held a diverse pool of mortgage-backed securities that received triple-A ratings from the rating agencies.

Still, lawsuits have alleged that many on Wall Street were fully aware of trouble in the housing market but chose to ignore it in their quest for more profit and higher bonuses. They point to
emails deriding securitized mortgages as garbage or worse at investment banks such as
Morgan Stanley(MS - Get Report),
Goldman Sachs(GS - Get Report) and
Deutsche Bank(DB - Get Report).

Another hypothesis, that a distorted belief that housing prices would continue to rise, led to terrible choices all around, has also been floated, though it gets a lot less credit.

A
new paper by Ing-Haw Cheng, Sahil Raina of the University of Michigan, and Wei Xiong of Princeton University, suggests that both poorly designed incentives and overly optimistic beliefs about housing prices among people involved with loan securitization, may have inflated the bubble. Preliminary findings from the report were first published in 2012, and the final results were published on March 12.

The researchers analyzed whether mid-level managers who were involved in issuing and investing in mortgage-backed securities - the very heart of the mortgage boom -- were actually aware of the housing bubble. Based on an analysis of the personal home purchase transactions of 400 mortgage securitizers, it looks like they weren't.

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